Some Thoughts on Buying Commercial Real Estate
Here are a few observations for people interested in buying real estate, based on my experience in representing buyers, sellers and lenders over the last 30 years. I don’t have all the answers, but these are my suggestions.
You may be a successful business person, professional or investor. And you are probably smart and a quick study, but that doesn’t mean you know the subtleties of buying and selling real estate. You don’t know what you don’t know. Get some professional help. You’re dealing with a lot of money and could expose yourself to personal liability.
What kind of help?
Start with a broker. In most cases, it doesn’t cost you anything. Usually, a buyer’s broker is paid from the commission paid to the seller’s agent at the closing. So get someone to help you find a property. They can also help you with pricing, location, terms, and other facets of evaluating property. You will also need a lawyer and probably a civil engineer (surveyor) unless the seller has a current survey. Depending on the type of property and the circumstances, you might also need to consult with an accountant or insurance agent.
Letter of Intent.
I like to begin with a term sheet or letter of intent which outlines the major terms. This allows the buyer and seller to determine if they can agree on the price and other big items before spending time and money drafting a contract. Be sure the letter of intent or term sheet clearly states it is non-binding until a formal agreement is prepared and signed by the parties.
Some commercial contracts are drafted by the buyer’s or seller’s attorney; other contracts may be presented by the broker for one of the parties on a fairly standard form. Although many terms on these broker forms are standard, a number of the important issues are open for negotiation. These include: Earnest Money—how much and when does it become non-refundable? Inspection Period—how long is it and what is inspected? Survey—what kind of survey and who pays for it? Warranties and Representations—will Seller make any and what are they? Or is the property sold “as is”? Title Insurance Costs—who pays? Also, state law requires a real estate contract to list the amount of special assessments against a property; some contracts omit this.
This is a period of time after the contract is signed for the buyer to inspect the property to determine if there is any reason the buyer would want to cancel the contract and not close. It is often called a “free look,” due diligence or feasibility period. It can be limited to inspection of certain things such as financing, zoning or environmental conditions; or it might give the buyer the right to cancel without giving any reason at all. It’s all negotiable. The time period varies, usually from 30 to 90 days, longer if re-zoning is required. But it’s not automatic. Some contracts are “as is” and the buyer has no inspection period. This is generally true for auctions too, which are recently becoming more popular.
The contract should provide that you receive a title commitment. This shows you the condition of the title; it is not a guaranty of good title. You have to read the commitment and object to title defects shown on the commitment, if any. Assuming the seller clears any title defects, the title insurance policy will insure that you own the property. But it doesn’t insure against such things as encroachments across boundary lines, lack of zoning for your desired use, a gap on the property, or violation of covenants on the property, to name a few. You need to order special endorsements for coverage against these risks. The cost for these endorsements can add up, so you need to weigh the cost against the risk for each property.
Many residential purchasers just order a boundary survey. You’ll usually want more for a commercial acquisition, an ALTA/ACSM Land Title Survey or some limited form of one. This shows, among other things, size of the property, building locations, boundaries, encroachments, easements, utility locations, street access, and recorded restrictions on the property. Surveys can be expensive so discuss the scope of the survey with the surveyor, your broker and attorney to determine what you need identified in the survey. These are usually paid for by the buyer, but it’s negotiable.
Get at least a Phase One environmental assessment. Your lender will require you to have one anyway. It should then qualify you for the innocent purchaser defense under the federal environmental clean-up laws. It’s also better to know if you have environmental problems before you purchase the property instead of later, when you sell the property and your buyer conducts an environmental assessment and finds a problem.
Take title of commercial property in an entity and not your own name to minimize your risk of personal liability. If you already have an entity, you may still want to set up a new entity just to own the real estate, depending on the situation. You may also want to consult with your insurance agent on liability and insurance risk issues depending on the type of property and its intended use.
You can get through the process of buying real estate on your own and might save some money by doing much of the work yourself. But if you do, you won’t know how much money you left on the table and if you have exposed yourself to future personal liability. When you are spending hundreds of thousands to potentially millions of dollars to buy the real estate, it makes sense to spend a few more dollars up front and do it right. You’ll also sleep better at night.
(Article appeared in Adams Jones November 2010 Newsletter)